WEAKNESSES

Income inequalities and persistent poverty, especially in the predominantly Russian-speaking eastern regions

Growth driven by domestic demand

Lively investment (25% of GDP in 2017) will continue to contribute to growth in 2019. Private investment will be supported by sustained business confidence and the high capacity utilisation rate, which stood at 77% in the third quarter of 2018. In addition, companies enjoy a tax exemption on reinvested profits. Public investment, boosted by European funds, will benefit the development of infrastructure, particularly in transport and education. However, growth is expected to slow in 2019. Private consumption – the traditional driver of growth – should continue to expand, but its contribution will be limited by a smaller increase in the employment rate. Wage growth, fuelled by the shortage of skilled labour as a result of emigration and population decline, is also expected to be lower. Nevertheless, slower inflation will boost household demand.

The industrial sector will remain concentrated around telephony, furniture and the automotive sector. With nearly 70% of industrial production being exported, the sector will benefit from its good level of competitiveness. However, cooler European growth could impact external demand, which is largely driven by neighbouring countries. This would have a severe effect on the country's economy, with industry generating 24% of GDP. At the same time, rail and road transport are benefiting now that the transit of capital goods to Russia has resumed. In addition, a transport cooperation agreement was signed in December 2017 to improve the train line between the two countries.

Comfortable financial situation

In 2018, growth in consumption and employment enabled public finances to show a surplus. This financial situation is expected to continue, with a fiscal strategy plan for 2019/22 that forecasts a government surplus in 2019, as well as a balanced structural balance (excluding cyclical effects). However, the local government surplus is expected to decline as a result of higher investment, with public spending by local government set to increase, particularly in the area of health (5.7% of GDP in 2019), and in promoting digitisation and innovation (4.4% of GDP in 2019). Revenues are expected to go up, even though the increase in excise duty on alcohol initially planned for 2019 was scrapped and consumption is forecast to slow.

Although it will show a slight decline, the current account surplus will remain comfortable. The decrease is mainly due to the widening trade deficit (3.8% of GDP in 2017), driven by increased imports. However, it will remain largely offset by the surplus in services, particularly related to IT and tourism (8.3% of GDP in 2017). Dividend repatriations by Swedish, Finnish and Dutch investors – who are very active in finance, real estate, supermarkets and industry – exceed the income from Estonian investments abroad, leading to an income deficit (2% of GDP in 2017). Large foreign direct investments (net inflows of 3% of GDP in 2017) are matched by portfolio investments made abroad by Estonian pension funds and insurance companies. External debt (83.5% of GDP in 2017), which is mainly private, is more than offset by the assets of residents held abroad.

The coalition is expected to be renewed after the parliamentary elections

After a vote of no confidence in 2016, Taavi Rõivas and the Reform Party gave way to a coalition formed around the leader of the Centre Party, Jüri Ratas, and including the Social Democrats (SDE) and Pro Patria Conservatives. This unprecedented coalition was made possible by the change of leadership within the Centre Party and the political representation of the Russian-speaking minority, who make up one quarter of the population and whose previous leader was considered pro-Russian and anti-NATO. In October 2018, the defection of a Pro Patria MP caused the coalition to lose its majority, as it now holds only 50 of the 101 seats. However, power is not expected to change hands, and things should remain as they are until the March 2019 election. The Reform Party and its new leader, Kaja Kallas, and the Centre Party of Prime Minister Ratas are neck and neck in the polls. The Reform Party's programme includes simplifying the tax system, promoting innovation and reducing state intervention in the economy. The eurosceptic Conservative Party (EKRE) is third in the polls, reflecting the rightward shift in the political landscape. Despite the stable political system, divisions between the Estonian ethnic majority and the Russian ethnic minority in the country remain a major challenge.

The business environment is quite good, although insolvency settlement can be a laborious process. The country could be hurt by a money laundering scandal involving Danske Bank. At the heart of the case is the Danish bank’s Estonian subsidiary, which allegedly transferred money of dubious origin that came from its portfolio of non-resident customers. A large part of this portfolio, estimated at €200 billion, is believed to be involved.